How to Set Up a Solo 401(k) Retirement Plan

by Remy Boyd

Solo 401(k)s are available for sole proprietors who want to save for retirement.

The benefits of entrepreneurship include work you love, favorable hours and a solo 401(k) retirement account. A solo 401(k) is accessible for sole proprietors with no employees, or one whose spouse earns income from your business, and wants to start or continue a retirement plan. An individual or solo 401(k) can lead to a future with a quality of life just as good, if not better, than the one you have now, if you treat it right. Among its key advantages -- you can sock away considerably more pre-tax money than you can with most other plans, including a traditional 401(k). And the solo 401(k) is simple to set up and maintain.

Account Types and Plan Options

Choose a traditional or Roth version of the solo 401(k) account. The traditional account allows you to set aside money on a pretax basis and the money grows tax-deferred until you withdraw it. You will pay income tax on the contributions to a Roth account, but the money will grow tax-free and you won't even pay taxes on it when you withdraw it. Solo 401(k) plans can be set up to give you the option of designating your contributions as Roth contributions or traditional contributions. If you do this, your annual contribution limit will apply to the total you put into the two plans combined.

Go online to research investment firms. Brokerage websites have sections dedicated to 401(k) information and include planning tools to help you find the right investment options for your retirement plans. Visit a full service brokerage firm to meet with a licensed financial advisor if you need or want in-depth advice on retirement planning, along with help setting up your 401(k).

Choose a portfolio of stocks, bonds and mutual funds for your account. The brokerage firm you choose will explain how to diversify your solo 401(k) portfolio, show you where to place contributions, how to monitor funds and evaluate performance. Talk to your advisor about what to do during periods of market volatility.

Understanding the Plan and Future Goals

Pay attention to the set up fees for solo 401(k) plans. Go to the company website for fee information and schedules, or ask your advisor for fee information before opening the account. This step is important because fees add up and work against the goal of long-term savings. Your account advisor is able to work the fees and fee schedule into your payment plan so that you stay on top of the extra cost.

Anticipate the use of the retirement fund. Have an idea of what you plan to do with the account when you reach retirement age so you know how much to contribute each month and how to allocate those contributions. Think about important considerations like age, current income and the cost of living in your area, or the area you plan to live in once you start making withdrawals. Talk to your financial planner or spouse to map out these important goals together.

Ask your advisor about solo 401(k) contribution limits. Under current rules, participants under age 50 can make the maximum contribution of $17,000, either pre-tax (traditional) or after-tax (Roth). The business can also contribute up to an additional 20 percent of the company's profits. The combined maximum of your contributions -- including your salary deferral contribution and your profit sharing contribution -- can come to no more than $50,000 or the company's total profit for the year, whichever is less. Participants over age 50 can contribute an extra $5,500 for a "catchup" contribution, so you have something to look forward to as you age with your company. If your spouse earns an income as an employee and participates in the solo 401(k), she can make separate contributions up to her personal limits, but keep in mind that your total contributions can never exceed the company's total profit for the year.

Tip

The money has to stay invested until age 59 ½ if you want to avoid early withdrawal penalties. Withdraw money before then and you will pay a 10 percent early withdrawal penalty and income taxes on the withdrawal amount on a traditional 401(k). You will pay those penalties only on the earnings in a Roth account. Ask a 401(k) advisor about early withdrawals and loan provisions as an option to include in your plan.

Resources

About the Author

Remy Boyd is a professional in the staffing and recruiting industry. She is the founder of RÉMY ORÉAN, a boutique communications firm that specializes in media content for the human resources, finance, and life and style industries.